Enphase Energy, Inc. (ENPH) Q3 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to Enphase Energy's Third Quarter 2015 Financial Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time [Operator Instructions]. As a reminder, today's program is being recorded. I would now like to introduce your host for today's program Christina Carrabino. Please go ahead.

Good afternoon and thank you for joining us on today's conference call to discuss Enphase Energy's third quarter 2015 results. On today's call are Paul Nahi, Enphase Energy's President and Chief Executive Officer and Kris Sennesael, Chief Financial Officer. After the market closed today, Enphase issued a press release announcing the results for its third quarter ended September 30th, 2015. We are providing an accompanying presentation with our earnings call that you can access in the Investors section of our Company's website at www.enphase.com. During the course of this conference call, Enphase management will make forward-looking statements, including, but not limited to, statements related to Enphase Energy's financial performance, market demands for its microinverters, advantages of its technology, market trends, future products and future financial performance. These forward-looking statements are based on the Company's current expectations and inherently involve significant risks and uncertainties. Enphase Energy's actual results and the timing of events could differ materially from those anticipated in such forward-looking statements as a result of these risks and uncertainties. Factors that could cause results to be different from these statements include factors the Company describes in its press release of today, especially under the section entitled Forward-Looking Statements, as well as those detailed in the section entitled Risk Factors of the Company's report on Form 10-K for the year ended December 31, 2014. Form 10-Q for the quarter ended June 30, 2015 and Form 10-Q for the quarter ended September 30, 2015, which will be filed with the SEC in the fourth quarter of 2015. Enphase Energy cautions you not to place undue reliance on forward-looking statements and undertakes no duty or obligation to update any forward-looking statements as a result of new information, future events or changes in its expectations. Also, please note that certain financial measures used on this call are expressed on a non-GAAP basis and have been adjusted to exclude certain charges. The Company has provided reconciliations of these non-GAAP financial measures to GAAP financial measures in its earnings release posted today, which also can also be found in the Investor Relations section of its website. Now, I'd like to introduce Kris Sennesael, Chief Financial Officer of Enphase Energy. Kris?

Good afternoon and thanks for joining us today to discuss our third quarter 2015 financial results. I'll start by providing some details related to the third quarter and provide the business outlook for the fourth quarter. As a reminder, the financial measures that I'm going to provide are on a non-GAAP basis unless otherwise noted. After that, Paul will provide an update on the state of the business and we will open up the call for Q&A. Total revenue for the third quarter of 2015 was $102.9 million, an increase of 4% compared to the third quarter of 2014 and an increase of 1% compared to the second quarter of 2015. We shipped 219 megawatt AC for approximately 258 megawatt DC during the third quarter of 2015. An increase of 28% on a year-over-year and an increase of 12% sequentially. The 219 megawatt shipped represented approximately 950,000 microinverters all of which were our fourth generation microinverter system. The Enphase M250 represented approximately 45% of all units shipped up from 35% last quarter, as we see an industry shift towards the adoption of higher power modules. Revenue from Vivint was approximately 8% of total revenue, down 45% compared to the third quarter of 2014. All over revenue excluding Vivint was up 18% compared to the third quarter of 2014. International revenue was 16% of total revenue and was up 26% year-over-year driven by strong growth in Australia and Continental Europe and despite some headwinds in the UK. Pricing pressure during the third quarter further increased as a result of this, and in order to continue growing our business. We have adopted a more aggressive pricing strategy. In the third quarter, average selling price decreased approximately 18% year-over-year on a price per watt basis. Including approximately 2 points due to Forex headwinds. The large year-over-year price reductions were largely offset by product cost reductions of approximately 16% year-over-year on a cost per watt basis. As a result, gross margin for the third quarter of 2015 was 30.9% down 210 basis points compared to the third quarter of 2014. Operating expenses during the third quarter of 2015 were $26.9 million, a reduction of approximately 11% compared to the second quarter of 2015 and much lower compared to the business outlook that we provided last quarter. The decreased was primarily driven by a $4 million decrease in incentive compensation expenses of which, $2.5 million represents a reversal of amounts accrued in the first half of this year. During the third quarter of 2015, R&D expenses were $10.9 million. Sales and marketing expenses were $9.9 million and G&A expenses were $6.1 million. Total non-GAAP operating expenses excluded $3 million in stock-based compensation expenses, $500,000 in severance cost and $700,000 from a favorable revaluation of reacquisition related contingent consideration liability. Non-GAAP operating income for the third quarter of 2015 was $4.9 million compared to non-GAAP operating income of $4.8 million in the third quarter of 2014. For both the third quarters of 2015 and 2014 non-GAAP net income was $3.8 million or $0.08 per diluted share. On a GAAP basis, net income for the third quarter of 2015 was $600,000 or $0.01 per diluted share compared to GAAP net income of $800,000 or $0.02 per diluted share in the third quarter of 2014. Turning to the balance sheet, we existed the third quarter of 2015 with a total cash balance of $22.5 million which included $17 million from our working capital facility. Cash flow from operations was an outflow of $6 million driven primarily by a sequential increase in accounts receivable of $8.3 million as a result of the timing of shipments during the quarter. Cash flow from operations was also impacted by $2.7 million increase in inventory to $36.7 million. Given the business outlook for the fourth quarter, I do expect a significant reduction in the accounts receivable level by year end. However, inventory will remain at an elevated level and we will drive down days of inventory on hand during the first half of 2016. During the third quarter, capital expenditures were $3.4 million and depreciation and amortization was $2.7 million. I remain confident that a combination of our net cash position and the availability of our $50 million working capital facility as well as our focus on working capital reductions will be sufficient to fund operations. Now let's discuss our outlook for the fourth quarter of 2015. We expect revenue for the fourth quarter 2015 to be within a range of $62 million to $70 million. The fourth quarter revenue decline is driven by a correction of higher inventory levels in our distribution channel and softer overall market demand. We expect gross margins to be within a range of 23% to 26% as a result of a more aggressive pricing strategy. We also expect non-GAAP operating expenses for the fourth quarter of 2015 to be within a range of $28 million to $30 million. As we begin to adjust our operating expenses to our lower gross margin profile. Now I will turn it over to Paul, who will provide an update on the state of the business.

Thank you, Kris. The second half of 2015 is turning out to be more challenging than expected. Pricing pressure on US business continues to increase. Forex is putting pressure on our international business margin and pricing and a share loss of our largest customer continues to affect our year-over-year growth. To accelerate the expansion of our business, we've adopted a more aggressive pricing strategy. Until recently, we've been able to outpace price reduction with cost reduction. With our new strategy, it will be more difficult to keep pace with cost reductions. As a result, we expect our gross margin to drop to the mid-20s. However, I'm confident that over the next 24 months we'll be able to drive down our product cost even more aggressively than ever before. As we stated on our earnings call last quarter, we firmly believe that because of our advanced design, semiconductor-based technology and proven cost reduction track record. The cost of our microinverter system will approach that of string inverters. We will be providing more details about product to cost reduction roadmap during our Analyst Day in New York City on November, 17. As we execute on our cost reduction roadmap over the next 2 years and gradually improve gross margin over time towards our target long-term model. We'll adjust our operating expenses to accommodate, a more aggressive pricing strategy. This will require a further optimization across the whole company. Each and every member of the leadership team is dedicated to this and is actively working on reducing expenses, where the target to bring down the quarterly operating expense level below $30 million. Over the next couple of years, we'll focus our efforts on product cost reduction. Geographic expansion and importantly our Home Energy Solution which includes our AC Battery storage system. In addition, we'll continue to drive efficiency improvement and leverage the entire company. Despite the near term challenges, we remain confident and more determined than ever. We know from direct experience that customers valued Enphase solution over competing products. The initial response to our AC Battery storage system and Home Energy Solution has been very exciting and we have confidence in our ability to dramatically reduce cost over the next couple of years, to be at the cost of string inverters. Now with a more aggressive pricing strategy, we can provide our customers with the features, quality, ease and simplicity of an Enphase system at very competitive pricing. During the third quarter, we announced some significant new partnerships including our agreement with SolarWorld to develop a new generation of integrated AC Solar modules for the worldwide market. As a reminder, an AC module is defined as a solar module with an integrated microinverter. There is been a significant increase in demand from large solar distributors, installers and fleet owners for a reliable, cost-effective and high performance AC module to reduce cost and streamline their supply chain. The pairing of our S-Series Microinverters and SolarWorld's Sunmodules will reduce capital and labor cost, as well as simply supply, chain and logistics. We anticipate announcing more AC module partnerships in the near future. Also during the third quarter, we took a major step towards delivering the Enphase Home Energy Solution with a launch of our next generation Envoy-S. Our Home Energy Solution is an integrated, scalable platform for solar generation, storage, control and total energy management. Designed to work with all Enphase microinverters, Envoy-S features consumption monitoring for energy usage insights, revenue grade metering, integrated Wi-Fi, flexible networking options, remote update capabilities and optional cellular connectivity. We also introduced the AC Combiner Box, during the third quarter. The most effective way to maximize the features and benefits of the Envoy-S. The device helped cut the Envoy installation time by as much as 50% and reduces interconnection and communications equipment cost by as much as 20%. To improve operational efficiency and Enphase now offers installers toolkit mobile app for smartphones and tablets. Using the toolkit installers can quickly and easily configure an Enphase System commission the Envoy-S and confirm a successful solar installation. This quarter, we started shipping our fifth-generation microinverter, the S230 and S280. This fifth-generation microinverter is an entirely new platform that enables advanced bridge functions, higher power conversion efficiency, pairing with higher power modules and the first ever bidirectional microinverter and as the first ever bidirectional microinverter. It will power our revolutionary AC Battery storage system. We believe storage will be a multi-billion dollar market. And will be essential in helping solar gain broader acceptance and higher penetration. Enphase is bringing the same technological innovation to storage, that we brought to Solar by pairing our innovative distributed architecture and system design, with what we believe is best-in-class battery chemistry in the industry. Recently, we announced that Australia and New Zealand will be the first markets to receive the Home Energy Solution. The dynamics of the residential solar market in Australia make it one of the most storage ready regions in the world. And our large and growing presence in the Australian solar market, make it a perfect place for the introduction of our Home Energy Solution. In addition the Australian Government recently announced that it wants to accelerate the deployment of battery storage in Australian households. Mainly as a means to mitigate peak demand, reduced cost for consumers and cut emissions. Homeowners in the region, want total control of their homes energy because of the combination of electricity rates, high solar penetration and declining feed-in tariffs. Our Home Energy Solution facilitates needs with compelling economics and sets the stage for an evolving energy market. We're joining with SA Power Networks in South Australia and Genesis Energy in New Zealand to test the systems. We're confident that our AC Battery storage system with its modular architecture and seamless integration into enlighten will be unique in its simplicity, ease of installation, performance and cost effectiveness. We will be rolling out the components of the Enphase Home Energy Solution in Australia and New Zealand starting in December. And the Enphase AC Battery storage system will be available in Australia and New Zealand during the second quarter of 2016. It's important to note, that interest in our AC Battery storage system is not limited to the Asia Pacific region. We've been in discussions with customers in Europe, The United States and other countries. And they're looking for, to offering the Enphase AC Battery storage system and Home Energy Solution in their markets. As an example, we're cautiously optimistic about the potential storage opportunities in Hawaii as a PUC recently issued a ruling to end net metering for all new solar customers in the state. Well this could prove challenging for the Hawaiian solar market in the near term. We believe it creates an opportunity for an Home Energy Solution that includes storage, to lower energy costs for all consumers. In closing, we're working diligently our cost reduction roadmap as well as new products including our fifth-generation microinverter system, the AC module, the AC Battery storage system and the Enphase Home Energy Solution. These will all help drive further long-term growth, with new and existing partners worldwide. Since inception, our vision has been to realize the global potential solar energy through our technology innovation. We're confident, we can overcome the near term pricing challenges and are more excited than ever about the new opportunities ahead. And now, open up the call for questions.

[Operator Instructions] Our first question comes from the line of Edwin Mok from Needham & Company. Your question, please.

I guess first question just, Paul talk about the near term. I think on your prepared remarks, you talked about all the challenge you need to work on inventory. How fast do you think that could happen and is that just in the US market or you're seeing some got work down in the international markets as well?

So we believe that we have a couple of weeks of inventory that we want to work our way through and we should be done with that in the fourth quarter and it's primarily in the US.

I see, okay and then, on the pricing front. You guys said, you talked about being more aggressive in pricing analysis, that has a negative effect on gross margin. And I think last quarter you said that, pricing was down 18% year-over-year, is that kind of the range that you guys are looking at pricing the product at this juncture and that caused to this pressure in gross margin or even more aggressive than that. And on the cost side, I remember you guys have finally have cost down version of your Gen four and Gen five, can you give us some rough timeframe and when those product can be available, will be helpful.

Sure, so as to the pricing itself, so yes, we've seen approximately 18% to 20% price reduction year-on-year between the second half of 2015 and the second half of 2014 and that obviously is going to have some downward pressure on gross margin and on revenue itself, however we've recognized that this is a very price competitive market. We also feel very comfortable given the empirical data that we have, that at or around competitive pricing, our customers will chose Enphase. So because of that, we've made the decision to become very aggressive on pricing. In fact, slightly ahead of cost which is where you see some of the challenges on gross margin? Having said that, we have a lot of experience and a great track record on cost reduction really since the inception of the company. The 18% price reduction you're seeing this year may very well be exceeded next year as a result of our potential cost reductions that we'll talking more about on our Analyst Day on November 17. So we're going to be sharing with you the details of our cost reduction roadmap over the next 24 years, which will show and hopefully provide the confidence that we can get very near string at or near string pricing costing which would put us in a very strong position globally to grab it even larger market share.

Okay that's helpful and last question I have, on the cost side kind of OpEx side. If I look at the model right now, where it's running at and kind of your revenue level, even just with some, [indiscernible] inventory that you talked about and it [indiscernible] one time actually you talked about for the last quarter. It seems like you guys are probably burning some cash on a kind of normalized run rate perspective. So my question I guess is, you have a number of programs to expand into Home energy management, right as well as development of microinverter. How do you kind of balance your cost, how you balance investment into all these programs versus cost control to try to maintain positive cash flow for business?

Yes, there is a lot there in your question and so first of all, we are going to drive down our operating expenses and as Paul already mentioned, to whole executive team including me are diligently working on that and we will take some actions in the fourth quarter and so you will see, we guided $28 million to $30 million of OpEx in Q4. The full impact of all our actions you will see that in the first quarter of 2016. And so obviously, we going as deep as we can, but there are a couple of limiting factors. Of course, we want to make sure that we can and will execute on our product reduction roadmap and that we deliver our AC Battery storage solution as part of our Home Energy Solution, on time to launch it in 2016 in Australia. So that are two very important things that we will continue to make major investments in it and because they're critical for the future of the company. We do believe that we will bring down operating expenses to in line with the lower gross margin profile of the company and that will result in a, I call it, approximately breakeven level from a cash flow point of view. Absent any working capital situations. As you probably know we have a very big seasonality in the business. Even sometimes within the quarters, we see fluctuations and so we will continue to have seasonal fluctuations there, that will impact our working capital, but absent working capital. We're at approximately breakeven level. So as you know probably know, we ended the quarter with $22.5 million of cash, we have and that included $70 million drawn down on the working capital facility. We have a working capital facility up to $50 million and so the combination of driving the business at breakeven, with better focus on managing our working capital, I feel confident that we cash and access to cash to go and run the business.

I see but the breakeven that you talk about, is not about what you guide for quarter end?

Sorry, can you repeat that Edwin?

Yes, sorry the breakeven, the approximate breakeven that was [indiscernible] normalized revenue levels, right not the fourth quarter revenue with guidance that you guys provided, right?

Yes, I mean it's clear that Q4 is a little bit of abnormal quarter and so it doesn't, you can't build any run rate or anything like from the fourth quarter. I was speaking about our expectations for 2016 and beyond.

Okay, great that's all I have. Thank you, appreciated.

Thank you. Our next question comes from the line of Colin Rusch from Oppenheimer. Your questions, please.

Can you walk us through a little bit more detail with the cash flow in the fourth quarter, obviously you're talking about drawing down receivable levels, where do you think you can get that to and actually in the quarter something like 50 days or do we, have to expect you to draw down further on that credit facility?

No and I typically don't guide on cash flow, but we had $6 million cash burn from operations during the third quarter, mainly driven by an increase in accounts receivable as well as still a slight increase in inventory levels. As I mentioned during the prepared remarks, we definitely do expect the accounts receivables to come down towards the end of 2015. Inventory, it will take some more time there. We need to reduce the build plans that will take some time and there is more work to be done there in the first half of 2016. But the combination of bringing down the accounts receivable level and other working capital elements that we have, I do expect to generate positive cash flow from operations in the Q4 of 2015. We will see, where we and [ph] today we have $17 million draw down on the working capital facility, we might pay back some of that depending on how much cash, we generate in the fourth quarter.

Okay and then as you look at right sizing the business. How should we think about that and when do you think, you'll make final decisions on which areas you're going to see the bigger cuts and how those are flow through?

So we're taking actions right now, as I mentioned in the prepared remarks. The entire executive team is very, very focused on this. You'll see the beginning of this in Q4, but you'll see I think most of the change is reflected in our Q1 operating expense. As Kris had mentioned, there are certain areas that we are very keen to protect mainly on the R&D side. The response that we're receiving to our storage solution, to our Home Energy Solution has been tremendous. We also have a lot of cost reduction activities that are going on, as well as things like the AC module, which is receiving a great deal of attention. So we're going to make sure that we continue to invest aggressively in all of these areas and in geographies where we're seeing expansion in growth, we're going to continue to invest there. However, there are definitely efficiencies that we can look to capitalize on and the rest of the company and we're going to evaluate that and as I mentioned, work on it both this quarter and you will see the effects of this mostly on Q1, 2016.

All right. I'll hop back in the queue and take some things offline. Thanks a lot, guys.

Thank you. [Operator Instructions] our next question comes from the line of Philip Shen from Roth Capital Partners. Your question please.

I'd like to touch on some far topics on, in terms of pricing and margins. Historically, your ASP declines have been in the 10% to 15% year-on-year decline level. What is the rate of ASP decline that you expect for 2016?

Phil, we're not - I'm not going to give you a specific number right now. What we will be doing is, on the 17, we'll share with you our cost reduction roadmap, which I think will provide a lot of visibility into our ability to reduce prices going forward. What I have said earlier, that we've seen an 18% to 20% price reduction, this year second half over second half. We will likely accelerate back in 2016.

Okay, that's helpful. So with the initial acceleration of price cuts. It seems like margins are in the mid-20s level. Let's see if the accelerating again, suffice to say, how low are you prepared for gross margins to go in 2016?

Well we're not getting any guidance as to gross margin, but we had mention had we, pricing actions we've taken will land us somewhere in the mid-20s and we think that, what we aspire to do is keep pace with that, throughout 2016.

Okay, thanks Paul. One other one here. In terms of the warranty and we've heard, that some inverter manufacturers out there, are exploring the possibility of reducing the length of time for warranties, as they reduce ASPs. What's your view on this in general and does that help alleviate some of the ASP declines?

So, well reducing the warranty, we'll certainly reduce the warranty reduce which could help on ASPs. I think the changes that we're talking about are really more substantial and more innovative. We - through our semiconductor development, we're able to reduce the part count, able to change things on the mechanical side, on the cabling side, we can uniquely take advantage of the new higher power modules that are out there too, yet again reduce cost. So we're not looking at addressing this problem through financial means, we're looking at addressing the increasing interest in lower prices to help our customers become more competitive through technology innovation.

And Phil, I think it's clear that for Enphase, quality and reliability is a key element of our value proposition. We're not willing to compromise on that. Maybe some of our competitors might be willing to do that, that is not what Enphase is doing. Quality and reliability is key. We continue to further improve our reliability of our product which is world class already and we're not willing to compromise on that.

I'm sorry to underscore Kris's point. The nature of some of our cost reductions actually will help in the reliability by reducing a number of components and increasing the content of our semiconductor devices, we also reduce a number of solder [ph] joints and make the device smaller. So much of what we're doing is going in the direction of increased reliability, while we increase our testing and performance as well.

Great, one more if I can. Did you guys take any revenue reserves perhaps for price protection?

We have our normal accounting practice that we apply rigorously every quarter and so there was nothing up normal there in Q3, this time.

Okay, great. Thank you, Kris. Thank you, Paul. I'll jump back in the queue.

Thank you. Our next question comes from the line of Michael Morosi from Avondale Partners. Your question please.

With respect to fourth quarter guidance in addition to the inventory build. You called out market weakness and that's different than the message that we got from, one of the leading players in the space the other day. So I just wanted to see, if you can elaborate on what you're seeing and any specific end markets or geographies that may have impacted that comment?

So what we've seen is that, some of the initial expectations for the growth of the US residential market. I think may have been call it 10% to 20% more than what we're seeing right now. I think the reality of the market growth year-over-year is probably closer to 40% to 60% not necessarily 60% to 80%. So we're definitely seeing good growth, solid growth but may be not the growth that was originally anticipated. As for its application across the US. I wouldn't say there is anyone area particularly affected except perhaps Hawaii.

Okay and then, you're digging a little bit more into the, the shipment guidance and the inventory picture. It seems like inventories might be 10% or 15% drag and even if, it were to go to zero, that's only limited downside from here. So it still seems like there might be somewhere else, where there has been some growth slippage and you never know that's in C&I or in, Tier 2, Tier 3 customers. So what you're seeing, on the competitive that's kind of outside of the inventory and the pricing that you guys referred to.

Sure. So part of the guidance is, as we talked about due to the inventory correction. So we've got a couple weeks that we want to, we want to burn through in the channel. In addition to that, we talked about the fact that we've seen a slightly softer market than expected. And then remember, year-on-year the second half of 2015 has seen an 18% to 20% price reduction over the second half of 2014. So you've got price reduction which is putting downward pressure on margin coupled with some of the other elements that I just mentioned, that collectively is definitely effecting Q4. In terms of market share in general, it's a mix bag and market share is rather difficult to come by. We do believe that, as you had mentioned in the Tier 3, the price delta between us and some competitors had gotten quite large and while in the past, that there was a tremendous. People are willing to pay a tremendous premium for Enphase, the pricing environment with our customers has gotten rather challenging. So we have to reduce that delta and that was the impetus behind the very aggressive pricing moves that we've taken to-date including in Q3 and what we're going to continue to do in the ensuing quarters.

All right and one more then I'll hop off. Can you share, what percentage you expect of Gen 5 shipments in Q4?

We're just ramping up our Gen 5 shipments and so I believe this will be around 10% to 15% of total shipments.

And then heading into first half of 2016.

You have to think about the vast majority of our shipments all of them [ph] in 2016 will still be the fourth generation. But fifth generation there will then as I said like starting from 10%, 15% probably going to 20%, maybe 25% towards the end of 2016.

Okay, very good. Thanks for taking the questions.

Thank you. Our next question comes from the line of Brian Lee from Goldman Sachs

And sorry to harp on the theme, but it seems pretty important here. Just first question from me would be, where are you seeing the most softness in demand trends. Is it mostly in the distribution channel or is it in direct sales? And related to that, is there any geo [ph] where you've seen more of an impact. I know you outlined Hawaii and anything else that you think is worth highlighting?

Nothing, outside of Hawaii, we're not seeing anything specific. And then when you're talking about market segmentation. We're not seeing at localized at any one particular segment. We're seeing it at sort of across the board.

So you're seeing within your distributor channel, where it sounds like you're making the most inventories just been fear [ph] that weakness is just as, I guess is equal to what you're seeing your direct sales with some of the larger customers, is that fair?

I think as a general comment, I say that's true. Obviously customer-to-customer you're going to see different trends. But as an example, one of things that we've seen in the distribution is some of the Tier 1s, some of the very large customers have made inroads and have actually started to have gained a bit of share, which is actually putting pressure on some of Tier 3s, which may have slowed some of that growth, again still growing but maybe not as fast as we had anticipated.

Okay, fair enough. Maybe switching gear towards the pricing pressure. Similar to the first question, where are you seeing the most acute pricing pressure. Is it really just across the board or have you seen it more concentrated at the larger installers. I know you guys have been making a more concerted effort and have been vocal about that in recent quarters, but wondering if that's, if you're seeing a differential in the pricing pressure from the different customer segments you're targeting here.

It's a good question. We - I think originally the pricing pressure started with the larger customers, but it really can never stay isolated there. It's just a matter of time before it trickles down into the Tier 2s and Tier 3s, so what we're seeing now is that pricing pressure, I think across the market. Although, as I mentioned it may have started with the larger customers. And our strategy has been to address that with the larger Tier 1s, with the Tier 2s. We've made we've had several Tier 2 design wins that we're very excited about, many of which we haven't announced yet. But I think the pricing move that we've made in the middle Tiers had a tremendous effect and now we're applying that same strategy to the Tier 3s as well.

Okay, thanks guys.

Thank you. Our next question comes from the line of Jeffrey Osborne from Cowen and Company. Your question please.

Just a couple of questions on my end. I was wondering, if with the new price points that we're talking about here, if there is any opportunity to gain share at the Tier 1s, given your comments that they seem to be taking share versus your bread and butter, Tier 2 and 3 customers historically.

It's very hard for me to give you definitive answer on that, but yes we do, we are, our intention is to get to a price point, where yes we can gain share across the board from the Tier 1s, continue to success revenue in the Tier 2s as well as the long-tail.

It sounds like at Analyst Day you'll be talking about the cost roadmap, I think you've typically in the past talked about all the fifth gen products, having a 20% to 25% cost reduction. It was a bit unclear if that's what you're seeing with the initial units or is that a volume or some kind of version two of it, that would come out at a later date, can you just kind of flush out from a high level what the cost reduction potential is with that and as a follow-up. If you're blowing out the inventory here, why wouldn't you accelerate the shift to gen five at a faster rate than what we saw with the M250 transition from the 215. It seems like that would be a good opportunity to move the market this way faster, as oppose to slower.

Sure. So let me address your first question. So what we're seeing right now, what we have said is, that we see significant cost reductions with each subsequent generation of product. However, we don't necessarily see it when we introduce the product. We see it, we introduce the product and then it gets cost reduced over time and we eventually see it. Again we'll provide more detail on the Analyst Day. But no, we're not seeing a 25% cost reduction with the introduction of the fifth generation. Again more details on that to come and again, we'll take you through not just 2016 but all the way through 2017 as well, so you can see the larger narrative. In reference to us moving more aggressively on the fifth generation, the S230 and S280. A lot of this is driven by module power, the higher power modules while you do see some in the market, it's still not the most prevalent modules out there. We expect to see a much higher prevalence of higher power modules towards the end of the year. So I think, our fifth generation inverter will certainly pick up market share as we move into the second half of the year and then again there is that coupled with the cost reduction actions that we are embarked on, will result I think in much quicker transition towards the back half of the year.

And Jeff as, the vast majority of our ship was in 2016 will still be the fourth generation, we will continue to drive down the product cost of that fourth generation as well. We've not hit the bottom there either, so we'll continue to drive down cost of Gen four as well.

Got it and just for the Analyst Day, will you be giving an updated target model? I think in the past you've talked about 40% gross margin that's probably optimistic at this point, but is that something in the mid-term you mentioned 2016 and 2017 formal targets that just, longer term what the company can look like, is that something you're either willing to share now or at that point?

Yes, we definitely at the Analyst Day, we'll talk a bit more about our financial models and all of that. Having said that, we see that margins are now dropping to the mid-20s, however and we said that during the prepared remarks as well. Our long-term target levels remains 35% to 40% and we believe that, once we will hit the bottom of the cost curve, given our unique value proposition, we will be able to command a premium and a margins into 35%, 40%. You have to think about that in a slightly different way. Today, our premium is probably $0.20 or $0.25 per watt. Once you get to the bottom of the cost curve, the premium might be $0.02 or $0.03 or $0.04 per watt or maybe a $100 or $200 per system. And that will pay off way much compared to the value of proposition that we provide in terms of higher energy production, lower design and installation cost, ease of installation and lower operations and maintenance cost.

Got it, thanks Kris for the detail.

Thank you. [Operator Instructions] and our next question comes from the line of Vishal Shah from Deutsche Bank. Your question please.

So Paul, I wanted to better understand how this near term demand environment is shipping up. And you've talked some seasonality in Q1. I mean, should we assume demand will continue to remain soft until early Q2 and will that have an impact on margins?

So well, there's certainly the market seasonality that we expect in Q1. I think that some of what's happening in Q4 is unique to Q4. So I'm not expecting to see the same level of seasonality that Enphase has seen in the past, in Q1.

Okay, but it's fair to say that sequentially your revenues and volumes will not necessarily grow and your margins may continue to remain under pressure at least until you're able to see some volume growth in the second half.

Again, we don't, we're not guiding to 2016 but with the pricing actions that we have taken and will take, I do expect to see that generate more demand and higher revenue growth.

Okay, that's fair and then in an environment, where 2016 US market let's say is up 30% to 40% from a volume standpoint. How should we think about, your volume growth next year, would you think you will be. I mean first of all, do you think that the adoption rate for microinverters is increasing or do you think, this year finally the revenues are going to be flat. Do you think, you're going to see some market share changes next year and how should we think about overall volumes next year?

Sure. So again, I think to-date we have been at a considerable price premium over our competitors. The strategic decisions that we're making right now is that, we know that and we have seen that when we're at or near competitive pricing, we will win more customers then not. So I fully expect that, this new pricing strategy will resolve in higher revenue. Again I'm not going to guide towards 2015. But we've already seen tremendous success, we've seen that in customers like Sunrun, we became a customer there for the first time as result of the extra energy harvest, the stability and quality of the product as well as the pricing. We've seen the same thing happen in Tier 2s, many of which we haven't, many of which designs We haven't announced yet, designs win we haven't announced yet and I'm fully expected to see the same thing in the Tier 3s. Now we're just talking about the US, we're also seeing tremendous growth in EMEA, in the APAC region. So I think there is a lot of growth and a lot of market penetration for microinverters yet to come.

That's helpful and just to clarify the $0.25 premium that you mentioned, is that after the price actions that you take, you'll be taking in Q4 or is it of Q3?

No that's historical.

Okay, with some of the recent satisfaction that you've taken, where do you think your premium is versus both the string and also with versus the leading competitor.

So we're not guiding to price, what we are saying is that, we're going to show you a cost reduction roadmap that will get us to the at or very, very near the cost of string inverters. What we do and how much of that we take to price, we'll have to see, it's going to be based on market conditions at the time. But we'll be in a position, where we could compete with a broader and broader piece of the market.

That's helpful. Thank you.

Thank you. This does conclude the question-and-answer session of today's program. I would like to hand the program back to Paul Nahi for any closing comments.

Thank you for joining us on the call today and we look forward to seeing you on November 17 at our Analyst Day in New York.

Thank you. Ladies and gentlemen for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.